The Stress Test Charade

Petrino DiLeo examines the Obama administration’s “stress tests” of major banks and shows how they were rigged to provide a positive result.

With great fanfare, the federal government late last week announced the results of its “stress tests” of 19 major banks.

The tests–designed to see how much capital banks might need if certain “worst case scenarios” played out–concluded that the banks collectively would need $74.6 billion in fresh capital to survive $599.2 billion in losses. That’s a lot of money. But every single bank, even the worst off, was judged to be solid, provided it raised the extra money.

The announcement came with pronouncements of success from the Obama administration, and was roundly cheers by the mainstream media. “The results released today should provide considerable comfort to investors and the public,” Fed Chair Ben Bernanke said in a statement. Edward Yingling, president of the American Bankers Association declared, “The results of the stress tests should put to rest the harmful speculation we have seen over the past few months.”

Bank of America was judged to be in need of the most money–$33.9 billion in additional capital. Wells Fargo and Citigroup were next, at $13.7 billion and $5.5 billion respectively. Seven other banks need between $600 million and $2.5 billion while nine institutions were deemed to not need any additional funds.

But there are a few of problems with the triumphant scenario projected by the Treasury Department and its cheerleaders in the media.

First, the stress tests weren’t all that stressful–they didn’t allow for the real scale of possible losses to come, say analysts. Second, the discussion of the results neatly skirts the issue of how exactly banks are supposed to come up $74.6 billion–the money is supposed to come from private markets, but no one is yet buying banks’ bad assets.

Third, the banks won big concessions from the government on what figures were finally reported. And last, the government is imposing a lenient condition on banks by allowing a Tier 1 capital ratio of 4 percent–which means banks could still have 25 times more money committed than assets to cover potential losses, which hardly provides much of a cushion for future crises. >>>